We’ve been pounding the table for over a month now that the place to make money is the Energy sector — specifically coal and natural gas — as we head toward the winter months. But how do we plan to trade slowing energy inflation?
And I know what you’re thinking. “Matt, didn’t you say earlier this week that inflation was historically high?”
Yes. Yes, I did. Which is precisely why we need to get ready for it to slow — what goes up, must come down right?
Let’s look at the data from this week. You’ll notice that I’ve circled the Consumer Price Index (CPI) and Producer Price Index (PPI).
Source: Bloomberg
Everyone, especially the Federal Reserve, was focused on that CPI number, which, as I said, was the highest since 1990.
I get it. That is newsworthy.
But if I’ve said it once, I’ve said it 100 times. CPI is a lagging indicator for inflation. It tells us what has already happened rather than what is about to happen.
And as a trader and investor, I don’t need to know what’s already happened. I watched it happen. I can’t trade the past. I need to know where we’re going so that I can formulate a plan.
So I look at PPI — a leading indicator for inflation.
How to Trade Slowing Energy Inflation
Whereas CPI was historically high, PPI was flat month on month. If you put those two pieces of information together, it’s a sign that we could see inflation slow down over the next few months rather than continue accelerating.
This change will mostly include slowing energy inflation.
In terms of commodity prices, there has already been a pullback over the past month in thermal coal, coking coal, iron ore, steel… and now natural gas.
Source: Bloomberg
With winter ahead and annual contracting season for steel producers not yet complete, I expect those markets to bounce.
But we need to pay attention to their overall momentum. Steel, iron ore and thermal coal all have negative one- and three-month momentum. Coking coal and natural gas have turned negative as well in the past month. The only one to turn a corner?
Copper. Which is why we targeted Freeport McMoran Inc. (NYSE: FCX) last week.
Source: Bloomberg
It’s worth noting that of all coal prices worldwide, only U.S. prices have held their value. That’s why Arch Resources Inc. (NYSE: ARCH) and Consol Energy Inc. (NYSE: CEIX) remain on our watchlist.
But the overall point when I talk about slowing energy inflation is that high prices don’t last forever.
PPI data is telling us that, sometime in the next two to four months, we will need to flip the script on commodities. We’ll have to move them from the long side to the short.
When that happens, we won’t put strong companies like ARCH and CEIX on the short side — we’ll target weaker ones instead.
And the long side of trading slowing energy inflation will consist of less commodities and more tech, retail and industrial stocks.
Those names will appear to us gradually, and, as they do, that should be a clue to you that the economy — which has been inflating for a year, more rapidly over the past month — is transitioning to a new state.
And I can only speak for myself, but I’m excited to figure out what that is.
So until next time, stay frosty.
All the best,
Matt Warder
Fortune Research
